"either an idiot... or possessed of a dangerous agenda and very cunning"

Sunday, 25 November 2012

Asset managers, expertise and pay

A long time ago, when I first got into the world of shareholder activism I was struck by the straightforward point that people within asset management businesses were unlikely to have expertise in labour and employment issues. Despite the growth of responsible investment, I think most people still go into the industry because they think investment management is interesting - financially and/or intellectually. They don't go into it because they want to explore the relationship between employment issues and firm performance and, therefore, what view shareholders should take of them.

Back then I thought that there was an opportunity for the labour movement to provide more information to investors to help them understand these links better, and as such devote greater attention to employment issues. The point being that if asset managers didn't have the expertise internally, we could at least help get them up to speed. 10 plus years on I'm less optimistic, primarily because of the instrumental way that most asset managers continue to look at the world, and ultimately labour is a big cost in their minds. It is striking, to me anyway, how little 'responsible investment' engages with employment issues compared to its embrace of environmental ones.

But all that aside, I think the point about expertise still stands. To push it on a bit, imagine if an asset manager, or group of asset managers, developed their own policy on how companies should interact with their staff. I don't mean fund an acadenic study looking and these issues and then develop recommendations. I mean imagine if they just had a bit of a think about what they believed was best, came up with a headline idea or two, with no real evidence to back them up, and then said to companies 'you should do this'. It would be ridiculous, wouldn't it?

Why, then, do we allow asset managers to play such an important role in executive pay reform? This is an area where there is actually a lot of both academic and real world evidence about what does and does not work in terms of reward and motivation. Yet this is also a field in which asset managers still get away with saying 'you should do this', in terms of changes in remuneration policy design, with typically no evidence provided in support.

Let's look at a particularly prominent example of the guff in this area - 'alignment'. This is a term that is widely used in shareholder discussions about executive pay. Yet, having read a lot of stuff about reward and motivation over the past three or four years, I don't think I've seen it used in any of the psychological literature in this area. I think the idea that sits behind it - that you come to share the interests of the shareholder simply through the nature of your reward - is even more challengeable. Rewards work well on simple, routine, measurable tasks but when they do work well arguably it's because the recipient is focused on the reward not the task, not because they have come to share the interests of the production line manager, or whoever. Indeed the whole problem of people gaming reward programmmes is surely evidence that recipients don't come to share their interests. In terms of behavioural theories of motivation, I'm not actually sure that 'alignment' even exists.

But in the investor corner of corporate governance land the existence of 'alignment' is taken as a given and its achievememt greatly sought after. What's more we already 'know' how to achieve it in principle, we're just nailing down the details of doing it in practice. It is taken as self-evident that paying in shares achieves alignment. This idea is so well embedded (despite the lack of evidence for it) that you only need to genuflect towards the concept of alignment in your executive pay reform proposal to enable to skip over any questions about motivation. Paying in share simply switches most people's minds off in these discussions, it is, apparently, so obviously A Good Thing. If we're worried that paying in shares based on short-term measures is bad, just push the measurement or holding periods out. Done. Simple.

Yet when we see how executives themselves talk about share awards it isn't obvious their interests have been aligned with those of shareholders simply because they have been paid in magic beans... sorry... shares. So one executive quoted in the PwC research on the psychology of incentives describes share schemes as a 'lottery ticket'. Lots of executives in the research don't like being paid the way asset managers say they should be paid, and significantly discount the rewards that are supposed to get them thinking like shareholders. And what's more, none of this info is hard to find. Criticism of performance-related pay has not been as visible as it is now for a long time.

Why then, in an area as politically charged as executive pay, are asset managers allowed to put forward proposals (ie career shares) that have no evidence provided in support of them, and rely on a core assumption that is challengeable? Why do we take it for granted that, despite the existence of much research about what works and what doesn't when it comes to motivation, asset managers without any expertise in this field can put foward their own ideas, and that they will be taken seriously?

The more I think about it the more I think it is no surprise that executive pay has got out of control since we've relied on shareholder oversight alone to act as a restraining force.

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About Me

I work at the International Transport Workers Federation on capital stewardship. I'm interested in developing a stronger voice for labour in the capital markets, responsible investment and corporate governance.
This blog represents my personal views only.